The panel also included discussions about the concern that, under tax reform, the general partner of a hedge fund that invests in late-stage venture capital deals or other short-term investments will only be entitled to receive long-term capital gain on its carried interest to the extent that the fund has held the relevant assets for more than three years before sale.
As a result, financial advisors to investor funds may find themselves looking for new ways to generate returns and longer term capital gains since their management fees are no longer deductible by certain investors.
“In addition, under the tax act, individual investors are limited in their ability to deduct losses from all trader funds, any other trades or businesses up to $500,000 for married couples,” Itri said.
A hedge fund will either be classified for tax purposes as a "trader" or "investor," depending upon the degree of the fund’s securities activities, including trading frequency, holding time and other factors, according to Itri. A high-frequency trading fund, for example, will generally be classified as a trader, while buy-and-hold funds will be classified as investor.
Although investors in trader hedge funds are still able to fully deduct their management fees and other investment expenses, individuals invested in investor-type hedge funds, such as buy-and-hold funds, can no longer deduct their investment expenses as miscellaneous itemized deductions under the new tax plan.
“Deductions for investment expenses are suspended through the 2025 tax year for individuals invested in investor funds, where in the past these expenses were deductible, subject to the 2 percent floor and phase-out limitations,” said Itri.